Division 7A – A new approach?

Consultation on the second round of the Board of Taxation’s review of Division 7A has now concluded and the Board is due to report to the Government in October of this year.

The Review Paper (titled Post Implementation Review of Division 7A of Part III of the Income Tax Assessment Act 1936) noted that none of the models consulted on in the first round of consultations was considered to adequately satisfy all policy requirements.

As a result, the Board put forward a new model for comment called the Transfer of Value Model (TVM).

In essence, the TVM addresses the revenue concerns raised by Division 7A (i.e. shareholders and their associates accessing money which has been preferentially taxed at the corporate tax rate without any dividend being paid) in accounting terms, based on temporary and permanent shifts of value:

temporary value shifts (loans and use of company assets)

permanent value shifts (payments and debt forgiveness)

The essential elements of the TVM are:

Common rules to equate the private use of assets with loans as temporary value shifts

A new basis for calculation of distributable surplus, using annual accounting adjustments based on principles of temporary and permanent value shifts (rather than the adjusted net asset value approach presently adopted by section 109Y)

A simplified regime for loans involving a single 10 year loan with flexible repayments options

A “tick the box” option for trusts which would result in UPEs and other loans made to that trust by a company to be taken outside the operation of Division 7A where the benefits of the funds accessed were effectively limited to funding the trust’s working capital (see below)

Self-correction of errors without the need to seek the Commissioner’s discretion under s109R.

The “tick the box” option arose out of concerns that loans and UPEs can be used by trusts to access concessionally taxed company funds not only to fund working capital requirements, but also to acquire “passive” investment assets. When those assets were sold, the trust would obtain the benefit of the 50% CGT discount, whereas the company would have been denied that concession.

There were no revenue concerns about trusts receiving loans or UPE funding for working capital. However there were revenue concerns that using company funds for passive investment s ran counter to the basic principles of progressivity in the Act.

Consequently, under the “tick the box” proposal, if a trust made this election, from that time it would be denied the benefit of the 50% CGT discount on any trust assets other than for:

Goodwill; or

the proportion of shares held by the trust in a company which represented the goodwill of that company.

An immediate question arises as to why a specific regime to enable trusts to access company funds for working capital purposes is being created but the provision of similar options for partnerships and sole traders with working capital requirements are not.

A serious question also arises as to the potential for additional complexity to be added to Division 7A, when one the principal objectives of the Review is relieve SME taxpayers from the compliance costs arising out of the current complexity of the Division.